Finding the smart money in private lending this year

Believe it or not, first-time investors are still getting into the fix and flip marketplace.

One of the reasons, according to RCN Capital CEO Jeff Tesch, is that the economy is a sustained period of growth and there’s a significant number of people who have a decent nest egg, whether that’s in the form of equity in another property or available cash reserves. Whatever their situation, they want to try their hand at investing.

For these first-timers, using a sophisticated lender with a dedicated underwriting team for their project as opposed to going the all-cash route provides an extra safety net. Having a lender look over their shoulder means they’re more likely to make the right choices with their first flip, Tesch said.

“They get the benefit from us really drilling down into their deal,” he said. “We’re doing a deep dive on their rehab list to see if that rehab list makes sense for their granular community (i.e., street, neighborhood), and once that rehab is paired up with the price they’re paying, are they going to make money? If they’re not going to make money, they won’t get a loan from RCN Capital no matter how well capitalized they are.”

Unfortunately for first-time flippers, however, the best bets in this space today are for experienced investors.

Tesch said that RCN’s most successful customers these days are the ones doing heavy rehabs, gut renovations that also increase available living space. This is especially true in California, where “square footage is everything.” Adding accessory dwelling units to existing spaces in particular are becoming increasingly popular.

“[These] could really boost the flipper’s returns because you’re adding a second unit, and for the investor, whether you’re renting or you’re going to put your family in the house and rent out the extra unit, it can really add a lot of value,” Tesch said. “The heavy rehabs go a long way to boosting your returns versus just paint and carpet.”

There’s a lot more at stake with these projects, however, and so RCN only offers these opportunities to investors who have three or more projects under their belt.

Another alternative to the get-in-and-get-out fix and flip strategy is the long-term rental market, which will continue to become an increasingly popular option in 2020.  The number of single-family homes and condos flipped in the third quarter of 2019 was down 12.9% from the previous quarter and 6.8% from the third quarter of 2018, according to the third-quarter 2019 U.S. Home Flipping Report form ATTOM Data Solutions. Home flips as a portion of all home sales decreased by 78% when compared to the previous quarter, which is attributed to a decline in borrow profits, even though financing costs have decreased. This has lead to an increased interest in rental program activity.

Tesch said that they’re seeing this at RCN as well. In December, 35% of originations at RCN Capital were for 30-year, non-owner occupied rental mortgages, a record for the company.

“Many of the folks who were buying, renovating, and selling aren’t getting the returns that they have seen before, so what they’re doing is, they’re buying, renovating, and holding for rental income,” he said. “They don’t want to take the short money from just flipping it because they’re not getting the returns that they had in the past, and also, in the majority of MSAs in the United States, rents continue to rise.”

Everyone’s waiting for the other shoe to drop and for the situation of 2007 to repeat itself, but Tesch said that even though there’s a runup in home prices, the main housing concern at the moment is the lack of single-family housing supply. As the population increases, there isn’t enough desired housing for everyone, and that’s where RCN is seeing the greatest growth.

“It’s got nothing to do with distressed housing, which is how we started back in 2010 . . . It’s taking dated housing and bringing it up to today’s standards to meet the demand, he said. “That tells the story of how we see our business moving forward, which is continuing to meet the demand of single-family housing in the United States through not only rehab, but building out rental stock as well.”

The circumstances surrounding new housing construction—or lack thereof—is benefiting investors and private lenders, as well as the attention of large capital partners. In 2019, the private industry in general has continued to grab more market share because, as the space has gotten more sophisticated, more traditional capital sources have found private lender more attractive than they have in the past. Everyone’s looking for smart money and well-secured returns, and Tesch said the space does just that.

Even more, he added, as the refi boom winds down and originators are taking a breath and looking around for more opportunities, they need to find new products to replace that activity.

“Now is the time, more than ever ,for these independent brokers to say ‘hey, what else is out there that I’m not leveraging in my local community?’ Investment property origination is an easy fit since it’s the product that they’re already dealing with, which is single family, 1-4 unit homes.”